Hockey has to get the tone right

For policymakers, businesses and investors around the globe it’s been quite a week, one that has rammed home the need to shore up ­Australia’s economic defences in an increasingly unpredictable world. Those charged with steering monetary and fiscal policy in this country faced the prospect that the world’s biggest economy and issuer of the international reserve currency might default on its debts. While the markets seemed to assume that Washington’s political theatre would never go that far, the high-stakes drama played out by the White House and ­Congress was at the least unsettling. In the wake of the ­temporary budget resolution, Australia’s outlook has been ­coloured by the dollar’s rise above US96¢, dashing expectations that it was on track to fall below US90¢.

Treasurer
Joe Hockey
was in the middle of all this at the G20 finance ministers’ and IMF meetings in Washington this week. Following the political drama on Capitol Hill seems to have made him more sharply aware of the volatility of the international environment confronting him for the next few years. Top Australian policymakers seem to have even contemplated the possibility that a US debt default may have sent the dollar rising to new record highs above greenback parity, even though the Reserve Bank has cut its cash rate to a record low 2.5 per cent. But, even without this, the dollar’s strength is being underpinned by the realisation that the US Federal Reserve board, soon to be lead by the “dovish"
Janet Yellen
, may not start ­winding back its massive money-printing operation until well into 2014. And, as Reserve Bank governor
Glenn Stevens
pointed out on Friday, the Chinese economy has remained resilient, in turn helping to hold up the prices Australia gets for its iron ore exports.

The dollar’s surprising strength is contrary to the Reserve Bank’s central game plan, which assumes that a sub-US90¢ ­dollar would boost trade-exposed parts of the economy as ­Australia’s mining construction boom comes off the boil. The ­central bank has been gently encouraging the dollar to fall by talking about the benefits of a more competitive exchange rate and explicitly leaving open the prospect that it might cut interest rates even further. By the end of this week, Mr Stevens openly conceded that, while the dollar was over-valued, it may not be within his gift to do much about it.

The currency market gyrations aren’t worrying the sharemarket investors that much because they are getting high on the drug of continued cheap money being pushed by the Fed. On Wall Street, investors pushed the S&P 500 to an all-time high the day after a temporary truce was reached in Washington while the Australian sharemarket hit a five-year high.

While any particular value of a country’s exchange rate is neither good nor bad, the dollar’s renewed strength will expose Australia’s uncompetitive cost structure left by the mining boom and an over-regulated business economy. That will continue to squeeze parts of the economy most exposed to foreign competition, such as car making and tourism, and continue to edge the jobless rate higher.

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The risk is that rising unemployment will put pressure on the Reserve Bank to cut official interest rates even further in order to stem the dollar’s rise, even though this will risk pumping up housing prices and storing up trouble for the future. Thankfully, the central bank realises there is a real limit to how much it can influence the price that the rest of the world wants to pay for our currency without causing problems elsewhere. Also thankfully, corporate leaders such as Wesfarmers’ Richard Goyder also recognise this, meaning that business must adapt to whatever the going exchange rate is. That means reducing their cost structures and becoming more productive.

This week was a reminder that Australia needs to be prepared for further sharp shocks from the global economy. And it needs to adapt to whatever dollar price the world markets set.